Wednesday, July 30, 2008

This post continues my ruminations about the effect that beliefs about income inequality may have on the happiness of people who hold those beliefs. Previous posts can be found here.

In order to study this it would be nice to have a natural experiment in which the population of a country began with fairly positive beliefs about inequality and then changed those beliefs radically over a couple of years. In order to draw conclusions we would need survey information to document the change in beliefs that occurred, together with information on happiness levels, income inequality and per capita income levels.

It just so happens that such information is available for Poland. A study by Irena Grosfeld and Claudia Senik shows that a change in attitudes toward inequality, which occurred around 1997, was associated with a sharp decline in satisfaction with the current economic situation and some decline in satisfaction with personal living standards despite continued economic growth (‘The emerging aversion to inequality: evidence from Poland 1992-2005’, Discussion Paper 3484, IZA, 2008, here).

Around 1997 there was a sharp drop in the proportion of people agreeing with the statement that inequalities of income are necessary for economic progress and a rise in the proportion agreeing that inequalities of income are too large in Poland.

The statistical analysis actually suggests that income inequality (as measured by the Gini coefficient) had a positive effect on satisfaction with the economic situation and satisfaction with personal living standards in the period from 1992 to 1996. The authors argue that inequality was initially interpreted as “an opening of new opportunities” following the fall of communism. It is somewhat easier to understand how this might occur in the light of the results of other research by Claudia Senik (discussed here) which suggests that in transition countries (Russia, Hungary, Poland and three Baltic countries) the life satisfaction of individuals tends to rise, rather than fall, when the income of their reference group -people with the same skills and occupation - increases. Her explanation is that in these countries people consider that their own future prospects to be better when the income of their professional peers rises.

Why did the change in attitudes toward inequality occur? Grosfeld and Senik suggest that “the turning point in tolerance for income inequality seems to come with the increasingly wide perception that the process that generates income distribution is itself unfair” (p17).

That suggests to me that a change occurred from a situation where the economic system was commonly viewed as a positive-sum game – potentially providing benefits to all participants - to one in which it was viewed as a zero-sum game – where the enrichment of some was perceived as being at the expense of others. Interestingly, the perception of an economy as a zero sum game can be an accurate perception when the distribution of income is influenced to a large extent by political favouritism.

All this leads me to wonder whether there is any survey evidence that people who perceive life as a positive sum game are generally happier that those who view it as a zero-sum game.

Monday, July 28, 2008

This may seem like an odd question. Many people would say that it must be true by definition that when we make good decisions we are happier. It seems to me, however, that this view is too simplistic.

In order to bring the discussion down to earth consider the case of a person who decides to devote more of her time to earning income and less to leisure. If you ask an economist whether she has made a good decision there is a fairly high probability that his response would be that along the lines of that suggested by Irving Fisher (1892) namely that individuals reveal their utility through their actions. He might say: “It is reasonable to presume that the combination of work and leisure that she has chosen makes her happier than the available alternatives”.

An alternative approach, favoured by psychologists and an increasing number of economists, would be to actually ask the person how happy (or how satisfied with life) she was both before and after she had made the decision to increase her hours of work. If her responses implied she was less happy – after the researcher had made allowances for other changes in her life in the intervening period – this approach would suggest that she had made a bad decision. In this instance this approach seems to suggest that the economist’s presumption of rational choice is wrong.

However, before rushing to judgement, consider a slightly different situation. In this case, rather than deciding to take on more paid work, the person concerned decides to have a child. Our conventional economist’s response would be the same – her decision to have a child implies that she is happier with this option than with the alternatives available. Our psychologist’s survey is likely to show that she is less happy (or less satisfied with life) than she was before giving birth. (There is evidence from many surveys that people who have children living at home are usually less happy than those in similar circumstances who do not have children.)

So, does this mean that our decision-maker made a bad decision by deciding to have the child? It could mean that, but I think that interpretation would usually make no sense at all. When women choose to have children they rarely regret their choices even though the sacrifices they make in looking after their “little bundles of joy” are sufficient to cause them to report lower happiness. By commonly accepted standards these are usually good decisions – they are sensible and rational.

Other examples can be cited of sensible and rational decisions that do not add to happiness, or only add to happiness for a short time. In the case of marriage, there is typically an increase in happiness for only a year or two before and after the event and then happiness returns to its previous level. Apparently cohabitation usually results in a smaller temporary increase in happiness than does marriage. Since separation and divorce have negative effects on happiness the whole idea of entering into relationships would seem problematic if viewed purely in terms of the happiness that people can reasonably expect based on the experiences of others.

My point is that there is more to life than self-reported happiness or life satisfaction. In his little book, “Happiness” (2005), Daniel Nettle identifies three levels of happiness: momentary feelings; judgements about feelings; and quality of life (flourishing or fulfilling one’s potential). Surveys of happiness and life satisfaction reflect the first two elements, but they usually fail to take account of the third element.

We seem to have been bombarded over the last year or so by arguments that the decisions people make cannot necessarily be presumed to make them happy. See here, here, and here for my discussion of books pushing such arguments. I think it is about time there was more recognition that good decisions do not always make people happy.

This point can be illustrated by returning to my first example of the person who was less happy after deciding to increase her hours of work. Isn’t it possible that this decision might have been a good one? How do we know that the person concerned had not decided to make some sacrifices in the short term in order to promote some longer term goal such as being able to afford to have children or to being able to give her children a better education? Happiness and life satisfaction indicators do not tell us the extent to which people are fulfilling the goals that are important to them.

Wednesday, July 23, 2008

This post provides some further thoughts on the question of why people who label themselves as being on the right of the political spectrum tend to be happier than those who label themselves as on the left.

In my last post on this subject (here) I discussed some research by Jaime Napier and John Jost which suggests that some of the association between political orientation and subjective well-being is accounted for by beliefs about inequality. The authors conclude that liberals tend to be less happy than conservatives because “they lack ideological rationalizations that would help them frame inequality in a positive (or at least neutral) light”.

Andrew Norton commented on his blog: “I think there is a better theory, one that is more consistent with the subjective well-being literature, which explains this result: that both lower average happiness and leftism have a common link to a weaker sense of personal control and optimism. Both these attributes are strongly correlated with happiness; and one of the tasks of the ‘positive psychology’ movement (the clinical side of subjective well-being research) is to try to enhance these senses” (here).

I responded:“My first thought was that a weak sense of personal control is likely to be more of a problem for low-income earners and the non-religious. Beliefs about inequality seem to be shown up as significant even in studies that control for both income levels and church attendance.However, I am attracted to James Buchanan’s argument that the strongest motivation for big government these days is that people are afraid to be free (references here). It seems to me that may be just another way of saying that a lot of people lack a sense of personal control.It is possible that beliefs about inequality and a sense of lack of personal control could both be relevant in explaining why those who self-identify as left are less happy. Arthur Brooks seems to combine both factors (see ‘Gross National Happiness’, pp 30-33). It would be interesting to see research which seeks to identify their relative importance.”

Having thought about this further I now doubt whether it would be possible to disentangle the effects of the relative importance of beliefs about inequality and feelings of lack of personal control to assess their relative importance as determinants of happiness. It might be more appropriate to view these factors as components of a syndrome – a combination of opinions, behaviour etc. .

I have come to this view after re-reading a section of “Gross National Happiness” in which Arthur Brooks discusses links between beliefs about upward mobility, feelings about inequality and happiness (pp 140-151). There is strong evidence that people on the left do tend to be pessimistic about upward mobility. In the case of people on below average incomes it makes sense that such beliefs would tend to result in feelings of lack of personal control (e.g. that nothing that they do makes any difference) and relatively low satisfaction with life, combined with leftish political views.

It is more difficult to see why pessimism about mobility should affect the happiness of people on above-average incomes. They might see lack of mobility as a social problem but they are not personally affected. Arthur Brooks suggests that these people tend to make themselves unhappy by repeating depressing messages about the perceived unfairness of income inequality. I suppose that is possible, but I have some difficulty in accepting that concerns about income inequality would, by themselves, have significant adverse effects on the happiness of people who have above-average incomes.

One possible explanation is that pessimism about income mobility might be just representative of a collection of beliefs (including for example beliefs about the environment) that would tend to reduce the happiness of people with above average incomes who have leftish views. When asked how happy they are these people might be inclined to think about the problems of the world and their perceived inability to do anything about those problems.

Monday, July 21, 2008

I have written on this subject before in comments on the book “Gross National Happiness” by Arthur Brooks (here) and in relation to some quick-and-dirty research I have undertaken myself.

To recap briefly, survey data show that Americans who label themselves as conservatives are nearly twice as likely to say they are very happy as are those who label themselves as liberals. This gap has persisted for 35 years and apparently cannot be explained in terms of income differences. Religion and marriage account for some but not all of this happiness gap. My research suggests that the finding that conservatives are happier than liberals also applies to other countries: a higher proportion of the population are satisfied with life in countries where people tend to position themselves toward the right of the political scale (here). It also suggests that differences between the happiness of high and low income people is influenced by differences in their political beliefs and in their beliefs about the importance of money and material things (here).

An article by Jaime Napier and John Jost (kindly brought to my attention by Andrew Norton) seems to me to shed light on the reasons why political beliefs influence happiness (‘Why are conservatives happier than liberals?’, Psychological Science, 19 (6), 2008). The study suggests that some of the association between political orientation and subjective well-being is accounted for by beliefs about inequality. The authors examined the effect of introducing ideological variables - relating to beliefs about inequality and meritocracy- in regression analyses explaining life satisfaction in the U.S. and nine other countries. They found that when the ideological variable was introduced into the analysis it took some of the explanatory power away from the political variable. The authors also report on a study which suggests that the gap in happiness between conservatives and liberals in the U.S. tends to become wider when the degree of income inequality rises.

The authors conclude that “inequality takes a greater psychological toll on liberals than on conservatives, apparently because liberals lack ideological rationalizations that would help them frame inequality in a positive (or at least neutral) light”. What they presumably mean is that people who label themselves as conservatives are less likely to worry about income inequality and this partly explains why they are happier than those who label themselves as liberals.

What are the implications of the finding that beliefs about income inequality influence happiness levels? It seems to me that when concerns about inequality are apparently having an adverse effect on happiness of large numbers of people we need more research to know more precisely what these people are concerned about and whether their concerns have a factual basis.

Thursday, July 17, 2008

This post continues my comments on “Nudge”, by Richard Thaler and Cass Sunstein. For earlier comments, see here.

In his comments on “Nudge”, Julian Sanchez, refers (here) to James Buchanan’s concept of ‘parentalism’. Whereas paternalism refers to the attitudes of elitists that sometimes people - other people - need to be restrained for their own protection from making poor choices, parentalism refers to the attitudes “of persons who seek to have values imposed on them by other persons, by the state or by transcendental forces” (James Buchanan, ‘Afraid to be free ...’, “Public Choice”, 2005, p 23).

Buchanan suggests that “many persons do not want to shoulder the final responsibility for their own actions. Many persons are, indeed, afraid to be free”. He argues that parentalism will be a more important “motivation for maintenance and extension of control over the activities of persons through collective institutions” during the first half of this century than other, more familiar, sources of socialism – managerial socialism, paternalistic socialism and distributionalist socialism.

If Buchanan is correct the classical liberal vision is likely to remain no more than a vision in the foreseeable future. In that context it becomes relevant to consider whether libertarian varieties of paternalism (or parentalism) are preferable to more coercive varieties. It seems to me that provisions enabling people to opt out of the nanny state are particularly important for people who do not want to have nanny’s values imposed upon them. Those who are at present content to accept the default options provided by the government’s choice architects may also benefit from being able to observe how other people fare when they opt to choose for themselves.

The question remains, however, of how libertarians could persuade other people to think twice before voting in favour of the use of choice architecture by governments to help them make better decisions in areas currently relatively free of government regulation. In this context it seems to me that Will Wilkinson makes a good point when he suggests that although Sunstein and Thaler may wish to design the presentation of choices to bias decisions in favor of, say, happiness, “other choice architects may be more interested in biasing our choices toward virtue or toward participation in great collective projects”. Wilkinson suggests that “political choice architecture may do a great deal to shape us, even if, in its libertarian paternalist incarnation, it makes a show of leaving the ultimate choice open to individuals” (here).

It seems to me that it is just as important for people to be vigilant in dealing with choice architects in government - who are attempting to serve many masters with differing objectives - as it is to be vigilant in dealing with choice architects in the private sector who have a clear responsibility to serve the interests of the shareholders of the firms they work for.

What is a nudge? In their book, “Nudge”, Richard Thaler and Cass Sunstein define a nudge as “any aspect of the choice architecture that alters people’s behavior in a predictable way without forbidding any options or significantly changing economic incentives” (p 6).

Thaler and Sunstein claim that nudges are consistent with libertarianism because they don’t involve coercion but they readily acknowledge that nudges are paternalistic. They advocate "libertarian paternalism".

An example might help to clarify what a nudge involves. If the government were to invest a certain proportion of your income in a superannuation fund on your behalf this would amount to a nudge (rather than a push or a shove) if you were allowed to withdraw the funds at any time to use as you wished. There is evidence that as a result of a tendency for people to avoid choices (or to choose the default options) such an arrangement would result in much more investment in superannuation than one that relied solely on tax incentives. It would do this without the interference in personal choice that is involved in compulsory superannuation, such as exists in Australia.

After reading “Nudge” I decided to read some reviews by other people to help clarify my own views. The basic idea that people’s behaviour can be influenced by so called “choice architects” seems to be widely accepted by reviewers. This does not surprise me because there is no real conflict between the conventional view of economists (as argued, for example by Tim Harford in “The Logic of Life”) that people respond to incentives and the view of psychologists and behavioral economists (for example, Dan Ariely) that people are “predictably irrational”. For elaboration, see here.

Some reviewers taking what seems to me to be a predictably irrational approach, attack Thaler and Sunstein for rejecting coercion. For example, in the New York Review of Books. John Cassidy argues: “Once you concentrate on the reality that people often make poor choices, and that their actions can harm others as well as themselves, the obvious thing to do is restrict their set of choices and prohibit destructive behavior” (see here). The fallacy in this argument was aptly described by Harold Demsetz as “the grass is always greener” fallacy (‘Information and efficiency: another viewpoint’, Journal of Law and Economics, 1969) . Cassidy seems to be claiming that if outcomes are imperfect when choices are not restricted they must necessarily be better when choices are restricted. Social experiments with prohibition of alcohol early last century and Keynesianism from World War II until the stagflation of the1970s should have taught everyone that government interventions do not always result in better outcomes.

Some other reviewers attack Thaler and Sunstein for being paternalistic. For example David Gordon of the Mises Institute argues: “Those who wish to preserve liberty must take people's actions as they find them, not substitute for them "better" or more "rational" actions, based on an assessment of what people "really" want.” He suggests that: “Those who find convincing the explanations of bad choices put forward by Thaler and Sunstein are free to make arrangements with others that will alleviate these problems. If you think that sudden impulses when confronted with tempting food will lead you to fall off your diet, you may contract with a friend to forfeit money should you fail to meet certain weight requirements. But, in a free society, doing so is up to you; the state may not nudge you into this sort of contract” (see here).

Although I have a great deal of sympathy for Gordon’s line of argument, I don’t think it settles the question. Even though I vote to preserve my liberty - and am prepared to accept the consequences - that doesn’t stop the majority of people from voting in favour of government action to nudge their decisions (and mine) in particular directions. I will consider the implications of this in my next post.

Wednesday, July 9, 2008

When I decided to write this a couple of days ago I had the impression that the Australian tax commissioner had sent a letter to Dick Smith, a successful Australian businessman and aerial adventurer, threatening him with dire consequences if he did not refrain from use of legal tax avoidance measures. As I gathered information together, however, a rather different story emerged.

The best place to begin is with the late Kerry Packer, who was the wealthiest person in Australia. When asked by a government member about his company's tax minimisation schemes (during a public inquiry in 1991) Packer famously replied:

"Of course I am minimising my tax. And if anybody in this country doesn't minimise their tax, they want their heads read, because as a government, I can tell you you're not spending it that well that we should be donating extra!"

A couple of weeks ago it seemed that Dick Smith had finally decided to follow Kerry Packer’s lead. Smith wrote, in a letter to the tax commissioner, that he didn’t agree with Packer’s statement at the time it was made “but I certainly do now”.

Smith’s letter to the tax commissioner was in response to a brochure sent to 1200 wealthy Australians. Having just looked at the brochure, merely out of curiosity, it seems to me that there is nothing particularly objectionable in it. The main message seems to be that it is important for wealthy people to get good advice about tax matters.

However, in his letter Smith made clear that what had led him to change his mind was a particular instance of waste and mismanagement in relation to defence procurement. It seems that the tax commissioner was just a convenient target for Smith’s letter.

When I first read the newspaper articles suggesting that Dick Smith had become a convert to Kerry Packer’s views on government spending and tax minimisation I thought this meant that he was about to put his considerable skills in capturing public attention to use in making the case for smaller government and lower taxes. I was wrong.

An article in “The Australian” on Monday indicates that Smith has now told the tax commissioner that he will not be “entering into any scheme to legally minimize my tax”. What did the commissioner do to get Smith to change his mind? It seems that he just appealed to Smith not to do anything that could reduce community confidence in the tax system.

So, how did Smith respond? Well, it seems to me that Smith’s response was the human equivalent of a puppy that whines until it gets attention and then rolls over onto its back and asks to have its tummy tickled. Smith asked the tax commissioner to publish a list of Australia’s 100 top taxpayers in order to give them recognition for their efforts. His reasoning seems to be that anyone in the list of Australia’s 100 top taxpayers must be a particularly virtuous person who deserves recognition for, in effect, volunteering to pay more tax than he/she is legally obliged to pay.

What nonsense. Some wealthy people who take advantage of opportunities legally available to avoid tax, in their efforts to maximise post-tax income, might still be included among the top 100 taxpayers. Moreover, it is possible for wealthy people to minimize their tax as a consequence of altruism rather than selfishness – people pay no income tax if they donate all their income to registered charities.

Wednesday, July 2, 2008

At the end of his column in “The Australian” today, Alan Wood told readers that this was his final column as economics editor.

So, what message did Alan view as sufficiently important to be the subject of this column?

I quote what seems to be Alan’s main point:“If Australia moves ahead of the rest of the world to curb carbon emissions, there will be no benefit to Australia or the world but a potentially very high cost to us, involving extensive restructuring and transfers of wealth within Australia and from Australia to emerging economies.”

I think that message is worth repeating. The rest of the column can be read here.

Tuesday, July 1, 2008

The best place to begin is with the misery index. What is the misery index? No, it isn’t a measure of the average happiness level of economists. The misery index is the sum of the inflation rate and the unemployment rate. The concept was apparently created by Arthur Okun in the 1960s (see here) but it wasn’t the best idea he ever had. (Arguably, Okun’s best idea was the ‘leaky bucket’ metaphor. Redistribution of income from the rich to the poor is like carrying water in a leaky bucket. Some of the contents of the bucket is lost in transit. More information can be found here.)

The problem with the misery index is that it assumes that a percentage point increase in inflation creates just as much misery as a percentage point increase in unemployment. That assumption might make some sense if we had no information about the relative amounts of misery caused by inflation and unemployment, but that is not the case.

The results of happiness research suggest that unemployment has large negative effects on satisfaction with life. Research suggests that an increase in annual income of over $40,000 (over and above unemployment benefits) would be required to give Australian males who are unemployed the same probability of experiencing high life satisfaction as someone who is employed. The corresponding income increase for women was estimated to be about twice as large (for reasons unknown). Larger required income differences have also been estimated for other countries (see Nick Carroll, ‘Unemployment and psychological well-being’, Economic Record, Sept. 2007).

Happiness research suggests that although inflation has significant negative effects on satisfaction with life these effects are smaller than the effects on unemployment. Using a large European data base, Justin Wolfers has estimated that a percentage point of unemployment causes about 5 times more unhappiness than a percentage point of inflation (‘Is business cycle volatility costly’, International Finance, 2003, here).

If we can assume that a similar ratio applies in Australia, would this mean that the Reserve Bank would have to be crazy to contemplate policy action that would reduce inflation by a percentage point if this was likely to result in an increase in unemployment of 2 percentage points? No. In order to do this calculation properly it is necessary to take into account the duration of these expected effects of policy actions. If the reduction in inflation is expected to be permanent and the increase in unemployment is expected to last for only one year, the policy action would make sense. A clever politician might even be able to sell such an outcome to the public as “the recession we had to have”.

The obvious point is that if the Reserve Bank is able to demonstrate its resolve to prevent inflationary expectations from taking hold it will be able to avoid resorting to the unpalatable option of inducing a recession in order to reduce inflation. Unfortunately, the Bank is under pressure from some economists to view recent increases in inflation as having been “imported” and hence to take no action against them. I don’t know how anyone can argue that inflation can be imported in a country that has a floating exchange rate - but that may not mean much because I still count myself among those who think that “inflation is always and everywhere a monetary phenomenon”.

Emancipation

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Welcome to Freedom and Flourishing. While you are here, why not take a look around and leave some comments.

There is a list of my most popular posts below. I am pleased that a post about characteristics of a good society, that I wrote in 2009, is still one of the most popular. That post captures some of the ideas about freedom and individual human flourishing that I think are most important.